This article is part 2 of a series. Read part 1 by clicking here.
The ability for the insurance company’s general account assets to earn returns that exceed what households could otherwise obtain, combined with the tax deferral provided by the insurance policy, means that it is possible for life insurance to serve as an attractive long-term fixed-income investment even net of its insurance costs for a lifetime death benefit. It is worth exploring the simple possibility that life insurance cash value can be a viable alternative to include in a household’s fixed-income investment portfolio. It is possible for the net returns on cash value to exceed the net returns on other fixed-income investment opportunities.
Exhibit 7.10 Whole Life Insurance Cash Value as a Fixed-Income Alternative
Exhibit 7.10 provides the details for this analysis. These numbers could be modified to account for different circumstances. I consider the case for a 40 old who could either pay a higher premium for whole life insurance to support a permanent death benefit while also growing cash value in the policy, or who could pay a lower premium to support his preretirement death benefit needs with term insurance and then invest the difference between the whole life and term life premiums into a fixed-income portfolio. In this example, I maintain the assumption that interest rates remain fixed at 3%, and I do not assume any additional yield premium for investments in the general account relative to what is available to the household on their own. As explained, the insurance company’s general account may be positioned to yield higher returns than available to households.
For bonds, the gross yield is 3%, but I must account for the impact of taxes, fees, and life insurance needs to determine the net yield. Assuming this individual will remain in the 25% tax bracket, the net yield on fixed-income assets must be reduced by 25%, or 0.75% of the 3% bond yield to pay the annual tax bill. As for fees, to be consistent in this example I assume that bonds can be obtained without fees as I do not otherwise charge fees within the insurance policies. Finally, in the term life scenario, the premium for term insurance is one-third of the premium for whole life insurance. Assuming this individual seeks life insurance through retirement at 65, only two-thirds of the potential funds are available to be invested into the bond portfolio. This reduces the net returns on bonds by an additional 1%. Overall, the net return on bonds in this example has fallen to 1.25%.
As for the returns on cash value, the problem is slightly more complex because the insurance costs vary over time (recall the discussion of Exhibit 7.2). The complexity is accounted for by using an internal rate of return calculation. The internal rate of return is the compounded growth rate required on policy premiums to generate the cash value of the policy. These returns can be calculated both for the cash value and for the death benefit. I specifically seek to calculate them for the cash value growth shown in Exhibit 7.2.
Life insurance cash value is not meant to serve as a short-term investment. Exhibit 7.11 tracks the net returns for cash value over the life of the policy through age 100. Cash value returns remain negative until age 51. This is when the cash value amount ($82,665) first exceeds the cumulative premiums paid up to that point ($82,476). It took 11 years. Then, at age 59 the net returns on cash value exceed those of the bond portfolio for the first time. As time passes, the net returns on cash value continue to grow. They exceed 2% at age 82 and are 2.27% at age 99. Meanwhile, the life insurance also supports a permanent death benefit.
As for bonds, the death benefit with the term policy ends at age 65. Subsequent net bond returns at age 65 could be higher (2.25%) if life insurance is no longer used, but this would not cause cumulative net returns to immediately jump to this higher level. If I account for the term premiums that did not enter into the bond portfolio in the same manner that part of the whole life premiums are used to fund the life insurance, I find that the net returns on bonds would trail the cash value returns for life, despite the term strategy not providing a permanent death benefit. Expressing the internal rate of return on the value of the bond portfolio relative to the cash flows used to invest in bonds and pay for term life insurance, the net return on bonds reaches only 1.44% at age 99 in this scenario.
With term insurance, there is no cash value to help offset future insurance costs as happens with whole life. This leaves the “buy term and invest the difference” strategy lagging behind permanently. Exhibit 7.11 further shows the net lifetime internal rates of return on the bond investments after also accounting for the term premiums. Bonds do not have an opportunity to catch-up to the permanent life insurance approach even after the term insurance ends and the subsequent net returns become higher in absence of the continuing death benefit.
Exhibit 7.11 Net Returns on Whole Life Insurance Cash Value and on Bond Investments
This analysis has demonstrated the potential for the net returns on cash value to exceed those on other fixed-income assets. It is important to remember that this is accomplished with less risk as well, because cash value is not exposed to interest rate risk. We must also not forget that a permanent death benefit also accompanies this cash value even after age 65. Moving away from our simplified world, comparisons would have to consider the potentially higher returns on the general account, the impacts of fees for both insurance and investments, and the interest rate risk experienced for bond assets.
All considered, net cash value returns may be quite competitive with net bond returns, so that even aside from the death benefit, whole life insurance could provide a preferable way to invest in fixed-income assets for the household with a long-term focus.
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*This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon.
Canadian dollar notches biggest gain in a month as stocks rally
The Canadian dollar strengthened to a one-week high against its U.S. counterpart on Thursday as investor sentiment picked up and domestic data showed that retail sales fell less than expected in July.
World stock markets rallied and the safe-haven U.S. dollar retreated from one-month highs as worries about contagion from property developer China Evergrande eased and investors digested the Federal Reserve’s plans for reining in the stimulus.
Canada is a major exporter of commodities, including oil, so the loonie tends to be particularly sensitive to investor appetite for risk.
“The assumption here is that (Fed interest) rate hikes are still a long way out and so equities markets can still perform with accommodative financial conditions,” said Mazen Issa, senior FX strategist at TD Securities in New York.
“Consequently, currencies that have a higher beta to the equity market, like the CAD, can do alright.”
U.S. crude oil futures settled 1.5% higher at $73.30 a barrel, while the Canadian dollar was trading up 0.9% at 1.2653 to the greenback, or 79.03 U.S. cents.
It was the currency’s biggest advance since Aug. 23. It touched its strongest level since last Thursday at 1.2628.
Canadian retail sales dipped 0.6% in July, compared with expectations for a decline of 1.2%, while a preliminary estimate showed sales rebounding 2.1% in August.
Canadian government bond yields were higher across a steeper curve, tracking the move in U.S. Treasuries.
The 10-year touched its highest level since July 14 at 1.335% before dipping to 1.330%, up 11.6 basis points on the day.
(Reporting by Fergal Smith; Editing by Nick Zieminski and Peter Cooney)
Why it is wise to add bitcoin to an investment portfolio – The Economist
“DIVERSIFICATION IS BOTH observed and sensible; a rule of behaviour which does not imply the superiority of diversification must be rejected both as a hypothesis and as a maxim,” wrote Harry Markowitz, a prodigiously talented young economist, in the Journal of Finance in 1952. The paper, which helped him win the Nobel prize in 1990, laid the foundations for “modern portfolio theory”, a mathematical framework for choosing an optimal spread of assets.
The theory posits that a rational investor should maximise his or her returns relative to the risk (the volatility in returns) they are taking. It follows, naturally, that assets with high and dependable returns should feature heavily in a sensible portfolio. But Mr Markowitz’s genius was in showing that diversification can reduce volatility without sacrificing returns. Diversification is the financial version of the idiom “the whole is greater than the sum of its parts.”
An investor seeking high returns without volatility might not gravitate towards cryptocurrencies, like bitcoin, given that they often plunge and soar in value. (Indeed, while Buttonwood was penning this column, that is exactly what bitcoin did, falling 15% then bouncing back.) But the insight Mr Markowitz revealed was that it was not necessarily an asset’s own riskiness that is important to an investor, so much as the contribution it makes to the volatility of the overall portfolio—and that is primarily a question of the correlation between all of the assets within it. An investor holding two assets that are weakly correlated or uncorrelated can rest easier knowing that if one plunges in value the other might hold its ground.
Consider the mix of assets a sensible investor might hold: geographically diverse stock indexes; bonds; a listed real-estate fund; and perhaps a precious metal, like gold. The assets that yield the juiciest returns—stocks and real estate—also tend to move in the same direction at the same time. The correlation between stocks and bonds is weak (around 0.2-0.3 over the past ten years), yielding the potential to diversify, but bonds have also tended to lag behind when it comes to returns. Investors can reduce volatility by adding bonds but they tend to lead to lower returns as well.
This is where bitcoin has an edge. The cryptocurrency might be highly volatile, but during its short life it also has had high average returns. Importantly, it also tends to move independently of other assets: since 2018 the correlation between bitcoin and stocks of all geographies has been between 0.2-0.3. Over longer time horizons it is even weaker. Its correlation with real estate and bonds is similarly weak. This makes it an excellent potential source of diversification.
This might explain its appeal to some big investors. Paul Tudor Jones, a hedge-fund manager, has said he aims to hold about 5% of his portfolio in bitcoin. This allocation looks sensible as part of a highly diversified portfolio. Across the four time periods during the past decade that Buttonwood randomly selected to test, an optimal portfolio contained a bitcoin allocation of 1-5%. This is not just because cryptocurrencies rocketed: even if one cherry-picks a particularly volatile couple of years for bitcoin, say January 2018 to December 2019 (when it fell steeply), a portfolio with a 1% allocation to bitcoin still displayed better risk-reward characteristics than one without it.
Of course, not all calculations about which assets to choose are straightforward. Many investors seek not only to do well with their investments, but also to do good: bitcoin is not environmentally friendly. Moreover, to select a portfolio, an investor needs to amass relevant information about how the securities might behave. Expected returns and future volatility are usually gauged by observing how an asset has performed in the past. But this method has some obvious flaws. Past performance does not always indicate future returns. And the history of cryptocurrencies is short.
Though Mr Markowitz laid out how investors should optimise asset choices, he wrote that “we have not considered the first stage: the formation of the relevant beliefs.” The return from investing in equities is a share of firms’ profits; from bonds the risk-free rate plus credit risk. It is not clear what drives bitcoin’s returns other than speculation. It would be reasonable to believe it might yield no returns in future. And many investors hold fierce philosophical beliefs about bitcoin—that it is either salvation or damnation. Neither side is likely to hold 1% of their assets in it.
This article appeared in the Finance & economics section of the print edition under the headline “Just add crypto”
An Atlantic Investment Bubble Will Help Companies Grow And Create Jobs – Huddle – Huddle Today
Blair Hyslop is the President of the Order of the Wallace McCain Institute. He is co-CEO, along with his wife, Rosalyn Hyslop, of Mrs. Dunster’s and Kredl’s Corner Market, New Brunswick-based companies that employ more than 200 people and have operations throughout Atlantic Canada.
As the Covid-19 pandemic raged around the world, the four Atlantic Canadian provinces came together in an unprecedented spirit of cooperation and collaboration to tackle the challenges it presented. The result was one the safest places in the world, with untold lives saved. That showed what we can do as a region when we work together.
Recently, a group of entrepreneurs from all four provinces came together to discuss ways to grow our economy and erase that gap that still exists with the rest of Canada.
It’s about controlling our own destiny and creating a region with more opportunities for our people.
The Atlantic Investment Bubble
The first item this group is proposing is the creation of an “Atlantic Investment Bubble” – a common equity tax credit to encourage investment across the region. Too often, businesses in Atlantic Canada struggle to find the investment needed to fuel growth compared to the rest of Canada. In fact, there is only $3 of Angel investment per capita in Atlantic Canada for every $28 invested nationally, according to the most recent figures.
That’s a huge gap, one that penalizes businesses in our region.
The challenge of finding investment affects all kinds of businesses – food producers like our company, Mrs. Dunster’s, as well as technology companies, manufacturers, tourism operators and more. We all face the same challenge – finding the capital needed to help our business grow.
Each province has its own equity tax credit aimed at encouraging local investment in local businesses. These work pretty well, as far as they go. They have different amounts of credit available and some outline support for only specific sectors. Yet the fundamental problem with this well-intentioned approach is that it ignores the regional nature of our business community.
As a region, we are simply just too small to operate only within our home provinces – we need to go to other provinces to find customers, vendors, employees, mentors and investors.
The provincial equity tax credits support investors who invest in a company in their home province. But if I wanted to encourage an investor in Nova Scotia, PEI or Newfoundland and Labrador to invest in Mrs. Dunster’s, they wouldn’t receive a tax credit. That becomes a disincentive to invest. A regional equity tax credit will address this problem and create a more robust investment environment within Atlantic Canada by promoting more interprovincial investment. That will help us close the gap with the national investment average.
How It Works
We propose a regional equity tax credit of 35 percent overlayed on the existing provincial programs and focused on sectors that will yield the most benefit to our region, including manufacturing, renewable energy, tourism, food and beverage, IT, aerospace, and cultural industries.
This approach will minimize the amount of legislative and regulatory changes required to implement the program. That’s important because speed matters here – one of the outcomes of the pandemic is there are billions of dollars on the sidelines looking for opportunities to be invested, including large amounts here in Atlantic Canada. By implementing a regional equity tax credit, we can repatriate our own money that too often gets invested in the public markets in Toronto or New York.
It means we can invest in our own potential.
We recognize, of course, that every dollar counts for provincial governments, and that they can’t spend scarce dollars on new programs without consequences. However, we believe that the Atlantic Investment Bubble will be self-sustaining, creating more new tax revenues than it costs.
We propose a four-year pilot program that is backstopped by the federal government, meaning it will have zero cost to the provincial governments. Based on our projections, this incentive would support nearly 50 companies in the first year. By year four after the first year of investment, this equity tax credit will have created over $50-million in labour income and added nearly $80-million to the region’s GDP.
Beyond the numbers, it will make our region more competitive and entrepreneurial. It will give Atlantic Canadian businesses the resources they need to grow, creating new jobs and new tax revenues.
Why You Should Care
Admittedly, a regional equity tax credit can seem like a niche idea. Why should you care about it?
I believe that Atlantic Canadians should be angry that our economy continues to lag behind the national average. It means our unemployment levels remain higher and our average incomes are lower.
It doesn’t have to be this way. We have the talent needed to grow our economy – we just need the fuel in the form of access to more capital.
The Atlantic Investment Bubble will make our business community stronger, creating access to more private sector investment that will help small- and medium-sized businesses grow and create more jobs for Atlantic Canadians, people just like you. It will make our region stronger, keeping your kids at home by providing them with meaningful opportunities.
The Government of Canada spends hundreds of billions each year providing services to Canadians. The modest expenditure to support the Atlantic Investment Bubble is a smart investment in the potential of Atlantic Canada. It is a short-term, not a long-term, expense that will deliver a strong Return On Investment by driving more private sector investment throughout Atlantic Canada.
The provincial governments in Atlantic Canada proved that they could work together in common cause during the height of the pandemic. They did a great job managing the crisis and have positioned the region strongly for the post-pandemic reality. We can build on that momentum with the Atlantic Investment Bubble.
There is already considerable support for the Atlantic Investment Bubble, including the Atlantic Canada Chamber of Commerce, Conseil économique du Nouveau-Brunswick, New Brunswick Business Council, the Order of the Wallace McCain Institute and TechImpact. They understand that this change will open investment in our region and help us achieve our true potential.
If you would like to learn more about this initiative, or to show your support, visit our website: www.atlanticinvestmentbubble.ca. If you are already sold on the benefits, speak to your MLA and MP and ask them to support this smart, cost-effective policy change.
Huddle publishes commentaries from groups and individuals on important business issues facing the Maritimes. These commentaries do not necessarily reflect the opinion of Huddle. To submit a commentary for consideration, contact editor Mark Leger: [email protected]
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